LEXMARK INTERNATIONAL INC /KY/ - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NO. 1-14050

LEXMARK INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 06-1308215
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

ONE LEXMARK CENTRE DRIVE
740 WEST NEW CIRCLE ROAD
LEXINGTON, KENTUCKY 40550
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(859) 232-2000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No ___

As of March 5, 2004, there were outstanding 129,513,276 shares (excluding shares
held in treasury) of the registrant's Class A common stock, par value $.01,
which is the only class of voting common stock of the registrant, and there were
no shares outstanding of the registrant's Class B common stock, par value $.01.
As of that date, the aggregate market value of the shares of voting common stock
held by non-affiliates of the registrant (based on the closing price for the
Class A common stock on the New York Stock Exchange on March 5, 2004) was
approximately $10,811,768,280.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information in the company's definitive Proxy Statement for the 2004
Annual Meeting of Stockholders, which will be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the end of the fiscal year, is incorporated by reference in Part III of this
Form 10-K.
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LEXMARK INTERNATIONAL, INC. AND SUBSIDIARIES

FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2003

PART I

ITEM 1. BUSINESS

GENERAL

Lexmark International, Inc., ("Lexmark") is a Delaware corporation and the
surviving company of a merger between itself and its former parent holding
company, Lexmark International Group, Inc., ("Group") consummated on July 1,
2000. Group was formed in July 1990 in connection with the acquisition of IBM
Information Products Corporation from International Business Machines
Corporation ("IBM"). The acquisition was completed in March 1991. On November
15, 1995, Group completed its initial public offering of Class A common stock
and Lexmark now trades on the New York Stock Exchange under the symbol "LXK."

Lexmark is a leading developer, manufacturer and supplier of printing
solutions -- including laser and inkjet printers, multifunction products,
associated supplies and services -- for offices and homes. Lexmark develops and
owns most of the technology for its laser and inkjet products and associated
supplies, and that differentiates the company from many of its major
competitors, including Hewlett-Packard, which purchases its laser engines and
cartridges from a third party. Lexmark also sells dot matrix printers for
printing single and multi-part forms by business users and develops,
manufactures and markets a broad line of other office imaging products. The
company operates in the office products industry. The company is primarily
managed along business and consumer market segments. Refer to Note 17 of the
Notes to Consolidated Financial Statements for additional information regarding
the company's reportable segments.

Revenue derived from international sales, including exports from the United
States, make up about half of the company's consolidated revenue, with Europe
accounting for approximately two-thirds of international sales. Lexmark's
products are sold in over 150 countries in North and South America, Europe, the
Middle East, Africa, Asia, the Pacific Rim and the Caribbean. This geographic
diversity offers the company opportunities to participate in new markets,
provides diversification to its revenue stream and operations to help offset
geographic economic trends, and utilizes the technical and business expertise of
a worldwide workforce. Currency translation has significantly affected
international revenue and cost of revenue during the past several years. Refer
to Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Effect of Currency Exchange Rates and Exchange Rate Risk
Management for more information. As the company's international operations grow,
management's attention continues to be focused on the operation and expansion of
the company's global business and managing the cultural, language and legal
differences inherent in international operations. A summary of the company's
revenue and long-lived assets by geographic area is found in Note 17 of the
Notes to Consolidated Financial Statements included in this Annual Report on
Form 10-K.

MARKET OVERVIEW(1)

In 2003, estimated worldwide revenue for the office and home printing hardware
and associated supplies market, including monochrome (black) and color laser,
inkjet and dot matrix printers, exceeded $40 billion. Lexmark management
believes that the total office and home printing output opportunity is expanding
as copiers and fax machines have begun to be integrated into multifunction
printers. Based on industry analyst information, Lexmark management estimates
that this expanded market revenue opportunity, which includes multifunction
products, copiers and fax machines, was approximately $80 billion in 2003, and
will grow annually at low- to mid-

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1 Certain information contained in the "Market Overview" section has been
obtained from industry sources. Data available from industry analysts varies
widely among sources. The company bases its analysis of market trends on the
data available from several different industry analysts.

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single digit percentage rates through 2006. Management believes that this
integration of print/copy/fax capabilities favors companies like Lexmark due to
its experience in providing industry leading network printing solutions and
multifunction printing products.

The Internet is positively impacting the distributed home and office printing
market opportunity in several ways. As more information is available over the
Internet, and new tools and solutions are being developed to access it, more of
this information is being printed on distributed home and office printers.
Management believes that an increasing percentage of this distributed output
includes color and graphics, which tend to increase supplies usage. Growth in
high-speed Internet access to the home, combined with the rise in digital camera
sales, is also contributing to increased photo printing on distributed devices.

The laser printer market is primarily serving business customers. Laser printing
products can be divided into two major categories -- shared workgroup printers,
which are typically attached directly to large workgroup networks, and lower
priced desktop printers attached to PCs or small workgroup networks. The shared
workgroup printers include color and monochrome laser printers that are easily
upgraded to include additional input and output capacity, additional memory and
storage, and typically include high performance internal network adapters. Most
shared workgroup printers also have sophisticated network management software
tools and some products (including Lexmark's) now include multifunction upgrades
that enable copy/fax/scan to network capabilities. Based on industry data,
within the overall distributed laser printer market, Lexmark has gained market
share over the past six years. At the end of 2003, the company estimated its
installed base of laser printers at 5.2 million units versus 4.8 million units
at year-end 2002.(2)

Laser printer unit growth in recent years has generally exceeded the growth rate
of laser printer revenue due to unit growth in lower priced desktop laser
printers and unit price reductions, and management believes this trend will
continue. This pricing pressure is partially offset by the tendency of customers
in the shared workgroup laser market to add higher profit margin optional
features including network adapters, document management software, additional
memory, paper handling and multifunction capabilities. Pricing pressure is also
partially offset by the opportunity to provide business solutions and services
to customers who are increasingly looking for assistance to better manage and
leverage their document-related costs and output infrastructure.

The inkjet product market is predominantly a consumer market but also includes
business users who may choose inkjet products as a lower priced alternative or
supplement to laser printers for personal desktop use. Additionally, over the
past two years, the number of consumers seeking to print digitally captured
images in their homes have driven the photo-based sector up significantly. The
greater affordability of inkjet printers, as well as the growth in the
inkjet-based multifunction devices (all-in-one printers), both with a focus on
delivering digital photos, have been important factors in the growth of this
market. Based on industry data, Lexmark has gained market share over the past
six years. Growth in inkjet product revenue has been slower than unit growth due
to price reductions, which management expects to continue. At the end of 2003,
the company estimated its installed base of inkjet products at 47 million units
versus 43 million units at year-end 2002.(2)

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2 Over the last few years, Lexmark has provided estimates of its laser and
inkjet installed base on an annual basis, usually in January of each year.
These estimates are derived from detailed models, which contain numerous
assumptions requiring the use of management's judgment, such as ink and toner
usage, economic life of the products, retirement rates and product mix. The
company continually updates these models internally and revises the
assumptions, as new information is discovered. While these installed base
amounts reflect management's best estimate when published, they are subject to
change based on subsequent receipt of additional or different data, or changes
in the underlying assumptions. There can be no assurance that any of the
assumptions are correct and management's estimates of the installed base may
differ materially from the actual installed base. Management undertakes no
responsibility to update the public disclosure of its estimate of the
installed base as new information is continuously discovered.

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The markets for dot matrix printers and most of the company's other office
imaging products, including supplies for select IBM branded printers,
aftermarket supplies for original equipment manufacturer ("OEM") products, and
typewriter supplies, continue to decline as these markets mature, and the
underlying product installed bases are replaced.

STRATEGY

Lexmark's strategy is based on a business model of building an installed base of
printers and multifunction products that generate demand for its related
supplies and services. Management believes that Lexmark has unique strengths
related to this business model, which have allowed it to grow faster than the
market over the past several years and achieve above average profitability in
the office and home printing output market.

First, Lexmark is exclusively focused on printing and related solutions.
Management believes that this focus has enabled Lexmark to be more responsive
and flexible than competitors at meeting specific customer and channel partner
needs.

Second, Lexmark internally develops all three of the key technologies in the
distributed printing business, including inkjet, mono laser and color laser.
Lexmark is also recognized as an industry leader in critical software
competencies related to printing, network connectivity/management and enhancing
document workflow. The company's technology platform has historically allowed it
to be a leader in product price/performance and also build unique capabilities
into its products that enable it to offer unique solutions (combining hardware,
software and professional services) for specific customer groups. This breadth
of technology capabilities has also enabled Lexmark to offer an extensive
product line alternative to the industry leader, Hewlett-Packard.

Third, Lexmark has leveraged its technological capabilities and its commitment
to flexibility and responsiveness to build strong relationships with
large-account customers and channel partners, including major retail chains,
distributors, direct-response cataloguers and value-added resellers. Lexmark's
path-to-market includes industry focused sales and marketing teams that deliver
unique and differentiated solutions to both large accounts and channel partners
that sell into the company's target industries. Retail-centric teams also have
enabled Lexmark to meet the specific needs of major retail partners and have
resulted in the company winning numerous "best supplier" awards over the last
few years.

Lexmark's business market strategy involves targeting large corporations, small
and medium businesses and the public sector to increase market share by
providing an array of high quality, technologically advanced products at
competitive prices. Lexmark also continues to identify and focus on industries
where it can differentiate itself by providing unique printing solutions and
related services.

Lexmark's strategy also continually focuses on enhancing its laser printers to
function efficiently in a networked environment as well as providing significant
flexibility and manageability to network administrators. Generally, Lexmark
leverages expertise gained from its exclusive focus on printing solutions and
its understanding of industry-specific customer requirements to provide unique
and customized printing solutions and related services tailored to address
specific industry customer needs.

The company's consumer market strategy is to generate demand for Lexmark
products by offering high-quality, competitively-priced products to consumers
and businesses primarily through retail channels. Lexmark develops its own
technology to meet customer needs for increased functionality, faster printing
and better print quality. Lexmark management believes that its core product
offerings in this market, including the "Z" and "X" families of inkjet printers
and all-in-one printers, will also help it to build brand recognition in the
retail channels. Lexmark has aggressively reduced costs while pushing the
performance and features of higher-end color inkjets into the sub-$100 sector
and all-in-one printers into the sub-$250 sector.

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Because of Lexmark's exclusive focus on printing solutions, the company has
successfully formed alliances and OEM arrangements with many companies,
including Dell, IBM, Lenovo (formerly Legend) and Sindo Ricoh. The entrance of a
competitor that is also exclusively focused on printing solutions could have a
material adverse impact on the company's strategy and financial results.

The company's strategy for dot matrix printers and other office imaging products
is to continue to offer high-quality products while managing cost to maximize
cash flow and profit.

PRODUCTS

Laser Products

Lexmark offers a wide range of monochrome and color laser printers,
multifunction products, and associated features, software, and application
solutions. In 2003, the company introduced a new line of monochrome laser
printers designed to serve both workgroup and desktop applications. The T634 and
T632 monochrome laser printers with print speeds of up to 45 and 40 pages per
minute ("ppm"), respectively, are designed to support large and medium
workgroups and have optional paper input and output features, including a
stapler and offset stacker. The T630 and T420d monochrome laser printers with
print speeds of up to 35 and 22 ppm, respectively, are designed to support
medium and small workgroups. For the personal sector of the market, the company
introduced the E323, E321 and E220 monochrome laser printers with print speeds
of up to 20, 20 and 18 ppm, respectively. The monochrome laser printer line
extends into the wide format sector of the market with the W820 and W812. With
print speeds of up to 45 ppm, the W820 is supported with an array of paper
handling and finishing options that make it well suited for departmental
printing needs. The W812 is a small workgroup printer designed for wide format
and specialty printing applications with print speeds of up to 26 ppm.

In 2003, the company introduced two single pass technology color laser printers,
the C752 and C912. The C752 features the company's internally developed color
laser technology and prints both monochrome and color pages at up to 20 ppm. The
C752 is designed for large and medium workgroups. The C912 prints both
monochrome and color pages at up to 28 ppm and supports printing on tabloid size
paper. The company also offers the C720, a small workgroup color laser printer
that prints at up to 24 ppm in monochrome and six ppm in color. Early in 2004,
Lexmark introduced the C752L, which makes high-speed color printing even more
affordable for businesses. The C752L prints both monochrome and color pages at
up to 20 ppm.

In 2003, the company introduced the X912e, X752e and X632e multifunction
products. Along with the X820e, these products include an intuitive touch screen
display and the ability to integrate with corporate directories and leverage
existing network security to regulate access. These characteristics make it easy
for users to scan paper documents and fax or e-mail them. Other multifunction
products introduced in 2003 by the company include the X632, X630 and X215, each
of which provides print/copy/fax/scan capability. The X215 is a compact,
integrated device, designed for desktop applications and personal use. The X720
is also offered by the company, and like the X912e and X752e, has the added
capability of printing, scanning and copying in color. Early in 2004, Lexmark
introduced the X422, which is a compact, integrated, network-ready,
multifunction product for workgroups.

The N4000e network adapter was announced by the company in 2003 to support
low-cost networking for desktop devices. MarkVision Professional, Lexmark's
print management software that provides remote configuration, monitoring, and
problem resolution of network print devices can be bundled with all business
printers and multifunction products. Application solution options that support
web, bar code, encrypted data and Intelligent Printer Data Stream ("IPDS")
printing are also available for most of the printers in the "T", "W", "C" and
"X" families of business printers to support specific customer environments.

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In early 2003, the company introduced the Lexmark Document Solutions Suite,
which is designed to minimize the expense and inefficiencies of manual,
paper-based processes that are costly and time-intensive. The Lexmark Document
Solutions Suite integrates three distinct document solutions which work
separately or together as an integrated solution. The Lexmark Document
Distributor helps improve information workflow by capturing and moving documents
faster, more efficiently and more accurately into a broader range of network
systems. The Lexmark Document Producer is an e-forms solution that empowers
customers to take control of the presentation and delivery of output from almost
any host system and thus avoid the cost of preprinted forms. The Lexmark
Document Portal enables users of a Lexmark multifunction product to find, view
and print network documents when and where they need them. The suite enables the
graphical e-Task interface featured on Lexmark network multifunction products to
be tailored to an individual, workgroup, business or industry, using friendly
and descriptive icons that allow users to quickly identify and select the
appropriate work process. It also extends this interface and e-workflow
capability to workstation users of the X215 and X6170 multifunction products.
Early in 2004, the company introduced the Lexmark Workgroup OCR Solution, which
enables users to easily transform paper information into versatile, electronic
documents that can be efficiently shared and used.

Inkjet Products

In 2003, the company broadened its consumer product line with the introduction
of its first "P" line of photo products, as well as its next generation "X" line
of all-in-one products and "Z" line of inkjet printers. Lexmark's inkjet
introductions included a wide range of innovative functions and photo features,
as well as proven technology, such as the Accu-Feed paper handling system.

Lexmark's "P" series launch into the photo market in 2003 was led by the P707
and P3150. These products deliver 4 x 6 inch photographs in less than sixty
seconds and include innovative features such as PrecisionSense technology, which
automatically determines the paper type loaded in the printer and automatically
aligns the print cartridges. In addition, the company's "P" series offers
six-color printing, borderless photographs, Lexmark Photo Center software and
includes a memory card reader for today's most popular digital media.

The enhancements to Lexmark's all-in-one inkjet products was led by the
company's first four-in-one flatbed product, the X6170, which offers
print/copy/fax/scan capabilities in an innovative design. The X6170 also
established new industry standards in productivity with its 100-sheet automatic
document feeder and PC-free color or black fax mode. The Lexmark "X" series
continues to define the multifunction category by offering up to 4,800 x 1,200
dots per inch ("dpi") printing and 48-bit color scanning in the sub-$100 sector,
with its X1150. The company has expanded its line of "X" inkjet printers to five
models with print speeds of up to 19 ppm in black and 15 ppm in color.

Lexmark's "Z" line of inkjet printers in 2003 is focused on delivering high
performance with ease of use features. The company introduced borderless
printing on its Z705, which also automatically determines the paper type loaded
into the printer to ensure high quality output. Lexmark's "Z" line of products
offer up to 4,800 x 1,200 dpi resolution, as well as maximum print speeds of up
to 17 ppm in black and 10 ppm in color.

Dot Matrix Products

The company continues to market several dot matrix printer models for customers
who print a large volume of multi-part forms.

Supplies

The company designs, manufactures, and distributes a variety of cartridges and
other supplies for use in its installed base of laser, inkjet, and dot matrix
printers. Lexmark is currently the

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exclusive source for new printer cartridges for the printers it manufactures.
The company's revenue and profit growth from its supplies business is directly
linked to the company's ability to increase the installed base of its laser and
inkjet products and customer usage of those products. Lexmark is an industry
leader with regard to the recovery, remanufacture, reuse and recycling of used
supplies cartridges, helping to keep empty cartridges out of landfills.
Attaining that leadership position was made possible by the company's various
empty cartridge collection programs around the world. Lexmark continues to
launch new programs and expand existing cartridge collection programs to further
expand its remanufacturing business and this environmental commitment.

The company also offers a broad range of other office imaging supplies products,
applying both impact and non-impact technology.

Service and Support

Lexmark offers a wide range of professional services to complement the company's
line of printing products including maintenance, consulting, systems integration
and fleet management capabilities. The company works in collaboration with its
customers to develop and implement comprehensive, customized printing solutions.
Fleet management services allow organizations to outsource fleet management,
technical support, supplies replenishment and maintenance activities to Lexmark.

The company's printer products generally include a warranty period of at least
one year, and customers typically have the option to purchase an extended
warranty.

MARKETING AND DISTRIBUTION

Lexmark employs large-account sales and marketing teams whose mission it is to
generate demand for its business printing solutions and services, primarily
among large corporations as well as the public sector. Sales and marketing teams
focus on industries such as financial services, retail/pharmacy, manufacturing,
government, education and health care. Those teams, in conjunction with the
company's development and manufacturing teams, are able to customize printing
solutions to meet customer specifications for printing electronic forms, media
handling, duplex printing and other document workflow solutions. The company
distributes its products to business customers primarily through its
well-established distributor network, which includes such distributors as Ingram
Micro, Tech Data, Synnex and Northamber. The company's products are also sold
through solution providers, which offer custom solutions to specific markets,
and through direct response resellers.

The company's international sales and marketing activities for the business
market are organized to meet the needs of the local jurisdictions and the size
of their markets. Operations in the U.S., Australia, Canada, Latin America and
western Europe focus on large account demand generation with orders filled
through distributors and retailers.

The company's business printer supplies and other office imaging products are
generally available at the customer's preferred point of purchase through
multiple channels of distribution. Although channel mix varies somewhat
depending on the geography, substantially all of the company's business supplies
products sold commercially in 2003 were sold through the company's network of
Lexmark-authorized supplies distributors and resellers who sell directly to end
users or to independent office supply dealers.

For the consumer market, the company distributes its inkjet products and
supplies primarily through more than 15,000 retail outlets worldwide. The
company's sales and marketing activities are organized to meet the needs of the
various geographies and the size of their markets. In the U.S., products are
distributed through large discount store chains such as Wal-Mart and Target, as
well as consumer electronics stores such as Best Buy and Circuit City, office
superstores such

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as Staples and OfficeMax, and wholesale clubs such as Sam's Club. The company's
western European operations distribute products through major information
technology resellers such as Northamber, and in large markets, through key
retailers such as Media Markt in Germany, Dixon's in the United Kingdom and
Carrefour in France. Australian and Canadian marketing activities focus on large
retail account demand generation, with orders filled through distributors or
resellers, whereas Latin American marketing activities are mostly conducted
through retail sales channels.

For both the business and consumer markets, the company's eastern European,
Middle East and African regions are primarily served through strategic
partnerships and distributors. Asia Pacific markets (excluding Australia) are
served through a combination of Lexmark sales offices, strategic partnerships
and distributors.

The company also sells its products through numerous alliances and OEM
arrangements, including Dell, IBM, Lenovo (formerly Legend) and Sindo Ricoh.

No single customer accounts for 10% or more of the company's consolidated annual
revenue.

COMPETITION

The company continues to develop and market new and innovative products at
competitive prices. New product announcements by the company's principal
competitors, however, can have, and in the past, have had, a material adverse
effect on the company's financial results. Such new product announcements can
quickly undermine any technological competitive edge that one manufacturer may
enjoy over another and set new market standards for price, quality, speed and
functionality. Furthermore, knowledge in the marketplace about pending new
product announcements by the company's competitors may also have a material
adverse effect on the company as purchasers of printers may defer buying
decisions until the announcement and subsequent testing of such new products.

In recent years, the company and its principal competitors, many of which have
significantly greater financial, marketing and/or technological resources than
the company, have regularly lowered prices on printers and are expected to
continue to do so. The company is vulnerable to these pricing pressures, which
could jeopardize the company's ability to grow or maintain market share and, if
not mitigated by cost and expense reductions, may result in lower profitability.
The company expects that as it competes more successfully with its larger
competitors, the company's increased market presence may attract more frequent
challenges, both legal and commercial, from its competitors, including claims of
possible intellectual property infringement.

The markets for printers and supplies are extremely competitive. The laser
printer market is dominated by Hewlett-Packard, which has a widely recognized
brand name and has been estimated to hold approximately 50% of the market.
Several other large vendors such as Brother, Canon, Samsung and Konica Minolta
also compete in the laser printer market.

As more data is distributed electronically, demand has risen for increased
device functionality to include print/copy/fax/scan capabilities, resulting in a
convergence of the distributed printing and copier markets. This converging
marketplace is highly competitive and, in addition to the traditional laser
competitors, includes large copier companies such as Canon, Ricoh and Xerox.

The company's primary competitors in the inkjet product market are
Hewlett-Packard, Epson and Canon, who together account for approximately 80% of
worldwide inkjet product sales. As with laser printers, if pricing pressures are
not mitigated by cost and expense reductions, the company's ability to grow or
maintain market share and its profitability could be adversely affected. In
addition, the company must compete with these same vendors for retail shelf
space allocated to printers and their associated supplies.

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Although Lexmark is currently the exclusive supplier of new printer cartridges
for its laser and inkjet products, there can be no assurance that other
companies will not develop new compatible cartridges for Lexmark products. In
addition, refill and remanufactured alternatives for some of the company's
cartridges are available and, although generally offering inconsistent quality
and reliability, compete with the company's supplies business. As the installed
base of laser and inkjet products grows and matures, the company expects
competitive refill and remanufacturing activity to increase.

The market for other office imaging products is also highly competitive and the
impact printing sector of the supplies market is declining. Although the company
has rights to market certain IBM branded supplies until December 2007, there are
many independent ribbon and toner manufacturers competing to provide compatible
supplies for IBM branded printing products. The revenue and profitability from
the company's other office imaging products is less relevant than it has been
historically. Management believes that the operating income associated with its
other office imaging products will continue to decline.

MANUFACTURING

The company operates manufacturing control centers in Lexington, Kentucky and
Geneva, Switzerland, and has manufacturing sites in Boulder, Colorado; Orleans,
France; Rosyth, Scotland; Juarez, Mexico; Chihuahua, Mexico and Lapu-Lapu City,
Philippines. The company also has customization centers in each of the major
geographies it serves. The company's manufacturing strategy is to retain control
over processes that are technologically complex, proprietary in nature and
central to the company's business model, such as the manufacture of inkjet
cartridges, at company owned and operated facilities. The company shares some of
its technical expertise with certain manufacturing partners, which collectively
provide the company with substantially all of its printer production capacity.
Lexmark oversees these manufacturing partners to ensure that products meet the
company's quality standards and specifications.

The company's development and manufacturing operations for laser printer
supplies, which include toners, photoconductor drums and charge rolls, are
located in Boulder. The company also manufactures toner in Orleans, France. Over
time, the company has made significant capital investments to expand toner and
photoconductor drum capabilities. Laser printer cartridges are typically
assembled by third party contract manufacturers in the major geographies served
by the company.

MATERIALS

The company procures a wide variety of components used in the manufacturing
process, including semiconductors, electro-mechanical components and assemblies,
as well as raw materials, such as plastic resins. Although many of these
components are standard off-the-shelf parts that are available from multiple
sources, the company often utilizes preferred supplier relationships to better
ensure more consistent quality, cost and delivery. Typically, these preferred
suppliers maintain alternate processes and/or facilities to ensure continuity of
supply. The company generally must place commitments for its projected component
needs approximately three to six months in advance. The company occasionally
faces capacity constraints when there has been more demand for its products than
initially projected. From time to time, the company may be required to use air
shipment to expedite product flow, which can adversely impact the company's
operating results. Conversely, in difficult economic times, the company's
inventory can grow as market demand declines.

Many components of the company's products are sourced from sole suppliers,
including certain custom chemicals, microprocessors, electro-mechanical
components, application specific integrated circuits and other semiconductors.
In addition, the company sources some printer engines and finished products from
OEMs. Although the company plans in anticipation of its

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future requirements, should these components not be available from any one of
these suppliers, there can be no assurance that production of certain of the
company's products would not be disrupted. Such a disruption could interfere
with the company's ability to manufacture and sell products and materially
adversely affect the company's business. Conversely, during economic slowdowns,
the company may build inventory of components as demand decreases.

RESEARCH AND DEVELOPMENT

The company's research and development activity for the past several years has
focused on laser and inkjet printers, multifunction products, associated
supplies, features, software and related technologies. The company has been able
to keep pace with product development and improvement while spending less than
its larger competitors by selectively targeting its research and development
efforts. It has also been able to achieve significant productivity improvements
and minimize research and development costs. The company's research and
development activities are conducted in Lexington, Kentucky and Boulder,
Colorado with recent expansion to sites in Kolkotta, India and Cebu City,
Philippines. In the case of certain products, the company may elect to purchase
products and key components from third party suppliers rather than develop them
internally.

The company is committed to being one of the technology leaders in its targeted
areas and is actively engaged in the design and development of additional
products and enhancements to its existing products. Its engineering efforts
focus on laser, inkjet, and connectivity technologies, as well as design
features that will increase efficiency and lower production costs. Lexmark also
develops related applications and tools to enable it to efficiently provide a
broad range of services. The process of developing new technology products is
complex and requires innovative designs that anticipate customer needs and
technological trends. Research and development expenditures were $266 million in
2003, $248 million in 2002 and $246 million in 2001. The company must make
strategic decisions from time to time as to which new technologies will produce
products in market sectors that will experience the greatest future growth.
There can be no assurance that the company can continue to develop the more
technologically advanced products required to remain competitive.

BACKLOG

Although the company experiences availability constraints from time to time for
certain of its products, the company generally fills its orders within 30 days
of receiving them. Therefore, the company usually has a backlog of less than 30
days at any one time, which the company does not consider material to its
business.

EMPLOYEES

As of December 31, 2003, the company had approximately 11,800 full-time
equivalent employees worldwide of which 4,200 are located in the U.S. and the
remaining 7,600 are located in Europe, Canada, Latin America, Asia, and the
Pacific Rim. None of the U.S. employees are represented by a union. Employees in
France are represented by a Statutory Works Council. Substantially all regular
employees have been granted stock options.

The company conducted restructurings in 2000 and 2001 which were intended to
result in approximately 2,500 employee separations. Employee additions to
support other initiatives have partially offset these employee separations
resulting in the number of company employees worldwide being reduced from
approximately 13,000 at December 31, 2000 to approximately 12,100 at December
31, 2002.

9

AVAILABLE INFORMATION

The company makes available, free of charge, electronic access to all documents
filed with the Securities and Exchange Commission by the company on its website
at http://investor.lexmark.com as soon as reasonably practicable after such
documents are filed.

EXECUTIVE OFFICERS OF THE REGISTRANT

The executive officers of the company and their respective ages, positions and
years of service with the company are set forth below.

Dr. Curlander has been a Director of the company since February 1997. Since
April 1999, Dr. Curlander has been Chairman and Chief Executive Officer of the
company. From May 1998 to April 1999, Dr. Curlander was President and Chief
Executive Officer of the company. Prior to such time, Dr. Curlander served as
President and Chief Operating Officer and Executive Vice President, Operations
of the company.

Mr. Morin has been Executive Vice President and Chief Financial Officer of the
company since January 2000. From January 1996 to January 2000, Mr. Morin was
Vice President and Chief Financial Officer of the company.

Mr. Rooke has been Executive Vice President and President of the company's
Printing Solutions and Services Division since October 2002. Prior to such time
and since May 2001, Mr. Rooke served as Vice President and President of the
Printing Solutions and Services Division. From December 1999 to May 2001, Mr.
Rooke was Vice President and President of the company's Business Printer
Division, and from June 1998 to December 1999, Mr. Rooke was Vice President and
President of the company's Imaging Solutions Division.

Mr. Bahous has been Vice President and President of the company's Consumer
Printer Division since March 2003. Prior to such time and since July 2001, Mr.
Bahous served as Vice President of Customer Services. From January 1999 to July
2001, Mr. Bahous served as Vice President and General Manager, Customer Services
Europe.

Mr. Bork has been Vice President, Tax of the company since May 2001. From
October 1996 to May 2001, he was Director of Taxes of the company.

Mr. Cole has been Vice President and General Counsel of the company since July
1996 and Corporate Secretary since February 1996.

10

Mr. Goodnight has been Vice President, Asia Pacific and Latin America since June
2001. From May 1998 to June 2001, Mr. Goodnight served as Vice President and
Corporate Controller of the company.

Mr. Pelini has been Vice President and Treasurer of the company since July 2003.
Mr. Pelini was employed by the company from 1991 to 1998 and was assistant
treasurer of the company from 1996 to 1998. Prior to rejoining the company in
July 2003, Mr. Pelini was Senior Vice President of Finance for Convergys
Corporation. He held various positions with Convergys since 1998, including that
of Vice President and Treasurer.

Mr. Stromquist has been Vice President and Corporate Controller of the company
since July 2001. From July 1999 to July 2001, Mr. Stromquist served as Vice
President of Alliances/ OEM in the company's Consumer Printer Division. From
November 1998 to July 1999, he served as Vice President of Finance of the
company's Consumer Printer Division. Mr. Stromquist is the husband of Jeri I.
Stromquist, Vice President of Human Resources of the company.

Ms. Stromquist has been Vice President of Human Resources of the company since
February 2003. From January 2001 to February 2003, Ms. Stromquist served as Vice
President of Worldwide Compensation and Resource Programs in the company's Human
Resources department. From November 1998 to January 2001, she served as Vice
President of Finance of the company's Business Printer Division. Ms. Stromquist
is the wife of Gary D. Stromquist, Vice President and Corporate Controller of
the company.

INTELLECTUAL PROPERTY

The company's intellectual property is one of its major assets and the ownership
of the technology used in its products is important to its competitive position.
Lexmark seeks to establish and maintain the proprietary rights in its technology
and products through the use of patents, copyrights, trademarks, trade secret
laws, and confidentiality agreements.

The company holds a portfolio of approximately 1,000 U.S. patents and over 350
pending U.S. patent applications. The company also holds over 2,500 foreign
patents and pending patent applications. The inventions claimed in these patents
and patent applications cover aspects of the company's current and potential
future products, manufacturing processes, business methods and related
technologies. The company is developing a portfolio of patents that protects its
product lines and offers the possibility of entering into licensing agreements
with others.

The company has a variety of intellectual property licensing and cross-licensing
agreements with a number of third parties. Certain of the company's material
license agreements, including those that permit the company to manufacture some
of its current products, terminate as to specific products upon certain "changes
of control" of the company.

The company has trademark registrations or pending trademark applications for
the name LEXMARK in approximately 70 countries for various categories of goods.
Lexmark also owns a number of trademark applications and registrations for
various product names. The company holds worldwide copyrights in computer code,
software and publications of various types. Other proprietary information is
protected through formal procedures which include confidentiality agreements
with employees and other entities.

The company's success depends in part on its ability to obtain patents,
copyrights and trademarks, maintain trade secret protection and operate without
infringing the proprietary rights of others. While Lexmark designs its products
to avoid infringing the intellectual property rights of others, current or
future claims of intellectual property infringement, and the expenses resulting
therefrom, could materially adversely affect its business, operating results and
financial condition. Expenses incurred by the company in obtaining licenses to
use the intellectual property rights of others and to enforce its intellectual
property rights against others also could

11

materially affect its business, operating results and financial condition. In
addition, the laws of some foreign countries may not protect Lexmark's
proprietary rights to the same extent as the laws of the United States.

ENVIRONMENTAL AND REGULATORY MATTERS

The company's operations, both domestically and internationally, are subject to
numerous laws and regulations, particularly relating to environmental matters
that impose limitations on the discharge of pollutants into the air, water and
soil and establish standards for the treatment, storage and disposal of solid
and hazardous wastes. Over time, the company has implemented numerous programs
to recover, remanufacture and recycle certain of its products and intends to
continue to expand on initiatives that have a positive effect on the
environment. The company is also required to have permits from a number of
governmental agencies in order to conduct various aspects of its business.
Compliance with these laws and regulations has not had, and in the future is not
expected to have, a material effect on the capital expenditures, earnings or
competitive position of the company. There can be no assurance, however, that
future changes in environmental laws or regulations, or in the criteria required
to obtain or maintain necessary permits, will not have an adverse effect on the
company's operations.

ITEM 2. PROPERTIES

The company's corporate headquarters and principal development facilities are
located on a 386 acre campus in Lexington, Kentucky. At December 31, 2003, the
company owned or leased 7.0 million square feet of administrative, sales,
service, research and development, warehouse and manufacturing facilities
worldwide. The properties are used by both the business and consumer segments of
the company. Approximately 4.5 million square feet is located in the United
States and the remainder is located in various international locations. The
company's principal international manufacturing facilities are in Mexico, the
Philippines, Scotland and France. The principal domestic manufacturing facility
is in Colorado. The company leases facilities for software development in India
and the Philippines. The company owns approximately 63% of the worldwide square
footage and leases the remaining 37%. The leased property has various lease
expiration dates. The company believes that it can readily obtain appropriate
additional space as may be required at competitive rates by extending expiring
leases or finding alternative space.

None of the property owned by the company is held subject to any major
encumbrances and the company believes that its facilities are in good operating
condition.

ITEM 3. LEGAL PROCEEDINGS

On December 30, 2002, the company filed a lawsuit against Static Control
Components, Inc. ("SCC") in the U.S. District Court for the Eastern District of
Kentucky alleging that certain SCC products infringe the company's copyrights
and are in violation of the Digital Millennium Copyright Act. The Court granted
the company's motion requesting a preliminary injunction ordering SCC to cease
making, selling or otherwise trafficking in the specified products. On March 31,
2003, SCC appealed the Court's decision to the Sixth Circuit Court of Appeals
and oral arguments for this appeal occurred on January 30, 2004.

On February 28, 2003, SCC filed a lawsuit against the company in the U.S.
District Court for the Middle District of North Carolina alleging that the
company engaged in anti-competitive and monopolistic conduct and unfair and
deceptive trade practices in violation of the Sherman Act, the Lanham Act and
various North Carolina state laws. That lawsuit was dismissed on October 15,
2003. On December 23, 2003, these claims were asserted against the company as
counterclaims in the company's case against SCC pending in the U.S. District
Court for the

12

Eastern District of Kentucky. SCC is seeking damages in excess of $100 million.
The company believes that the claims by SCC are without merit, and intends to
vigorously defend them.

The company and Pitney Bowes, Inc. ("PBI") are involved in litigation in the
U.S. District Court for the Eastern District of Kentucky in which PBI alleges
that certain of the company's printers infringe the claims of PBI's patent
4,386,272, and that such infringement is willful. The company believes, based on
the opinion of outside counsel, that it does not infringe the patent. The
company believes the claims are without merit, and intends to vigorously defend
them.

The company is also party to various litigation and other legal matters,
including claims of intellectual property infringement and various purported
consumer class action lawsuits alleging, among other things, various product
defects and false and deceptive advertising claims, that are being handled in
the ordinary course of business. In addition, various governmental authorities
have from time to time initiated inquiries and investigations, some of which are
ongoing, concerning the activities of participants in the markets for printers
and supplies. The company intends to continue to cooperate fully with those
governmental authorities in these matters.

Although it is not reasonably possible to estimate whether a loss will occur as
a result of these legal matters, or if a loss should occur, the amount of such
loss, the company does not believe that any legal matters to which it is a party
is likely to have a material adverse effect on the company's financial position
or results of operations. However, there can be no assurance that any pending
legal matters or any legal matters that may arise in the future would not have a
material adverse effect on the company's financial position or results of
operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

13

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Lexmark's Class A common stock is traded on the New York Stock Exchange under
the symbol LXK. As of March 5, 2004, there were 1,636 holders of record of the
Class A common stock and there were no holders of record of the Class B common
stock. Information regarding the market prices of the company's Class A common
stock appears in Part II, Item 8, Note 18 of the Notes to Consolidated Financial
Statements.

DIVIDEND POLICY

The company has never declared or paid any cash dividends on the Class A common
stock and has no current plans to pay cash dividends on the Class A common
stock. The payment of any future cash dividends will be determined by the
company's board of directors in light of conditions then existing, including the
company's earnings, financial condition and capital requirements, restrictions
in financing agreements, business conditions, tax laws, certain corporate law
requirements and various other factors.

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information about the company's equity compensation
plans as of December 31, 2003.

(Number of securities in millions)
- --------------------------------------------------------------------------------

(1) The numbers in this column represent the weighted average exercise price of
stock options only.

(2) As of December 31, 2003, of the approximately 11.8 million awards
outstanding under the equity compensation plans approved by stockholders,
there were approximately 11.3 million stock options (of which 11,040,000 are
employee stock options and 274,000 are nonemployee director stock options),
246,000 restricted stock units and supplemental deferred stock units, 21,000
voluntarily deferred performance shares that were earned as of the end of
2000, and 203,000 elective deferred stock units (of which 159,000 are
employee elective deferred stock units and 44,000 are nonemployee director
elective deferred stock units) that pertain to voluntary elections by
certain members of management to defer all or a portion of their annual
incentive compensation and by certain nonemployee directors to defer all or
a portion of their annual retainer, chair retainer and/or meeting fees, that
would have otherwise been paid in cash. Of the 10.9 million shares
available, 8.3 million relate to employee plans (of which 3.1 million may be
granted as full-value awards), 0.2 million relate to the nonemployee
director plan and 2.4 million relate to the employee stock purchase plan.

(3) The company has only one equity compensation plan which has not been
approved by its stockholders, the Lexmark International, Inc. Broad-Based
Employee Stock Incentive Plan (the "Broad-Based Plan"). The Broad-Based
Plan, which was established on December 19, 2000, provides for the issuance
of up to 1.6 million shares of the company's common stock pursuant to stock
incentive awards (including stock options, stock appreciation rights,
performance awards, restricted stock units and deferred stock units) granted
to the company's employees, other than its directors and executive officers.
The Broad-Based Plan expressly provides that the company's directors and
executive officers are not eligible to participate in the Plan. The
Broad-Based Plan limits the number of shares subject to full-value awards
(e.g., restricted stock units and performance awards) to 50,000 shares. The
company's board of directors may at any time terminate or suspend the
Broad-Based Plan, and from time to time, amend or modify the Broad Based-
Plan, but any amendment which would lower the minimum exercise price for
options and stock appreciation rights or materially modify the requirements
for eligibility to participate in the Broad-Based Plan, requires the
approval of the company's stockholders. In January 2001, all employees other
than the company's directors, executive officers and senior managers, were
awarded stock options under the Broad-Based Plan. All 1.2 million awards
outstanding under the equity compensation plan not approved by stockholders
are in the form of stock options.

14

ITEM 6. SELECTED FINANCIAL DATA

The table below summarizes recent financial information for the company. For
further information refer to the company's financial statements and notes
thereto presented under Part II, Item 8 of this Form 10-K.

(Dollars in Millions, Except per Share Data)
- --------------------------------------------------------------------------------

(1) All data prior to 2002 has been reclassified in accordance with EITF 00-25
and clarified by EITF 01-9, resulting in a reduction to both revenue and
selling, general and administrative expense in the amount of $38.5 million
in 2001, $39.7 million in 2000 and $38.6 million in 1999.

(2) Amounts include the impact of restructuring and other charges in 2001 of
$87.7 million ($64.5 million, net of tax), which resulted in a $0.48
reduction in diluted net earnings per share. Inventory write-offs of $29.3
million associated with the restructuring actions were included in cost of
revenue.

(3) Amounts include the impact of restructuring and related charges in 2000 of
$41.3 million ($29.7 million, net of tax), which resulted in a $0.22
reduction in diluted net earnings per share.

(4) Amounts include the benefit of a ($5.9) million (($4.4) million, net of tax)
reversal of restructuring and other charges in 2002, which resulted in a
$0.03 increase in diluted net earnings per share.

(5) Provision for income taxes in 2001 includes a $40 million benefit from the
resolution of income tax matters, which resulted in a $0.30 increase in
diluted net earnings per share.

(6) Cash flows from investing and financing activities, which are not presented,
are integral components of total cash flow activity.

(7) The debt to total capital ratio is computed by dividing total debt (which
includes both short-term and long-term debt) by the sum of total debt and
stockholders' equity.

(8) Represents the approximate number of full-time equivalent employees at
December 31 of each year.

15

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis should be read in conjunction with the
consolidated financial statements and notes thereto:

OVERVIEW

Lexmark International, Inc. ("Lexmark" or the "company") is a leading developer,
manufacturer and supplier of printing solutions -- including laser and inkjet
printers, multifunction products, associated supplies and services -- for
offices and homes. The company also sells dot matrix printers for printing
single and multi-part forms for business users and develops, manufactures and
markets a broad line of other office imaging products. The company is primarily
managed along business and consumer market segments. Refer to Note 17 of the
Notes to Consolidated Financial Statements for additional information regarding
the company's reportable segments.

Over the past several years, the worldwide office and home printing output
opportunity has expanded as copiers and fax machines have been integrated into
multifunction products. Lexmark's management believes that this integration of
print/copy/fax/scan capabilities favors companies like Lexmark due to its
experience in providing industry leading network printing solutions and
multifunction printing products. Lexmark's management believes that its total
revenue will continue to grow due to projected overall market growth for 2004 to
2006.

In recent years, the company's growth rate in sales of printer units has
generally exceeded the growth rate of its printer revenue due to sales price
reductions and the introduction of new lower priced products in both the laser
and inkjet printer markets. In the laser printer market, this pricing pressure
is partially offset by the tendency of customers to add higher profit margin
optional features including network adapters, document management software,
additional memory, paper handling and multifunction capabilities. Pricing
pressure is also partially offset by the opportunity to provide business
solutions and services to customers who are increasingly looking for assistance
to better manage and leverage their document-related costs and output
infrastructure. In the inkjet product market, advances in inkjet technology have
resulted in products with higher resolution and improved performance while
increased competition has led to lower prices. The greater affordability of
inkjet printers, as well as the growth in the all-in-one category, have been
important factors in the growth of this market.

As the installed base of Lexmark laser and inkjet printers and multifunction
products continues to grow, management expects the market for supplies will grow
as well, as such supplies are routinely required for use throughout the life of
those products. While profit margins on printers and multifunction products have
been negatively affected by competitive pricing pressure, the supplies are a
higher margin, recurring business, which the company expects to contribute to
the stability of its earnings over time.

The company's dot matrix printers and other office imaging products include many
mature products such as supplies for IBM printers, typewriter supplies and other
impact technology supplies that require little ongoing investment. The company
expects that the market for these products will continue to decline, and has
implemented a strategy to continue to offer high-quality products while managing
cost to maximize cash flow and profit.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Lexmark's discussion and analysis of its financial condition and results of
operations are based upon the company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of consolidated financial
statements requires the company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue and expenses, and related

16

disclosure of contingent assets and liabilities. On an ongoing basis, the
company evaluates its estimates, including those related to customer programs
and incentives, product returns, doubtful accounts, inventories, intangible
assets, income taxes, warranty obligations, copyright fees, product royalty
obligations, restructurings, pension and other postretirement benefits, and
contingencies and litigation. The company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.

The company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.

Revenue Recognition

The company records estimated reductions to revenue at the time of sale for
customer programs and incentive offerings including special pricing agreements,
promotions and other volume-based incentives. Estimated reductions in revenue
are based upon historical trends and other known factors at the time of sale.
The company also provides price protection to substantially all of its reseller
customers. The company records reductions to revenue for the estimated impact of
price protection when price reductions to resellers are anticipated. If market
conditions were to decline, the company may take actions to increase customer
incentive offerings, possibly resulting in an incremental reduction of revenue
at the time the incentive is offered.

Allowances for Doubtful Accounts

The company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
company determines the estimate of the allowance for doubtful accounts based on
a variety of factors including the length of time receivables are past due, the
financial health of customers, unusual macroeconomic conditions, and historical
experience. If the financial condition of the company's customers deteriorates
or other circumstances occur that result in an impairment of customers' ability
to make payments, additional allowances may be required.

Warranty Reserves

The company provides for the estimated cost of product warranties at the time
revenue is recognized. The reserve for product warranties is based on the
quantity of units sold under warranty, estimated product failure rates, and
material usage and service delivery costs. The estimates for product failure
rates and material usage and service delivery costs are periodically adjusted
based on actual results. To minimize warranty costs, the company engages in
extensive product quality programs and processes, including actively monitoring
and evaluating the quality of its component suppliers. Should actual product
failure rates, material usage or service delivery costs differ from the
company's estimates, revisions to the estimated warranty liability may be
required.

Inventory Reserves and Adverse Purchase Commitments

The company writes down its inventory for estimated obsolescence or unmarketable
inventory equal to the difference between the cost of inventory and the
estimated market value. The company estimates the difference between the cost of
obsolete or unmarketable inventory and its market value based upon product
demand requirements, product life cycle, product pricing, and quality issues.
Also, the company records an adverse purchase commitment liability when
anticipated market sales prices are lower than committed costs. If actual market
conditions are

17

less favorable than those projected by management, additional inventory
write-downs and adverse purchase commitment liabilities may be required.

Long-Lived Assets

Management considers the potential impairment of both tangible and intangible
assets when circumstances indicate that the carrying amount of an asset may not
be recoverable. An asset impairment review estimates the fair value of an asset
based upon the future cash flows that the asset is expected to generate. Such an
impairment review incorporates estimates of forecasted revenue and costs that
may be associated with an asset, expected periods that an asset may be utilized,
and appropriate discount rates.

Pension and Postretirement Benefits

The company accounts for its defined benefit pension plans and its non-pension
postretirement benefit plans using actuarial models required by Statement of
Financial Accounting Standards ("SFAS") No. 87, Employers' Accounting for
Pensions, and SFAS No. 106, Employers' Accounting for Postretirement Benefits
Other Than Pensions, respectively. These models use an attribution approach that
generally spreads the expected liability for projected benefits over the service
lives of the employees in the plan and require that explicit assumptions be used
to estimate future events. Examples of assumptions the company must make include
selecting the following: expected long-term rate of return on plan assets, a
discount rate that reflects the rate at which pension benefits could be settled,
and the anticipated rates of future compensation increases.

The assumed long-term rate of return on plan assets and the market-related value
of plan assets are used to calculate the expected return on plan assets. The
required use of an expected versus actual long-term rate of return on plan
assets may result in recognized pension income that is greater or less than the
actual returns of those plan assets in any given year. Over time, however, the
expected long-term returns are designed to approximate the actual long-term
returns and therefore result in a pattern of income and expense recognition that
more closely matches the pattern of the services provided by the employees. For
the market-related value of plan assets, the company uses a calculated value
that recognizes changes in asset fair values in a systematic and rational
manner. A five-year-moving-average value is used for equities and high-yield
bonds due to the volatility of these types of investments and fair value is used
for all other bonds. Differences between actual and expected returns are
recognized in the market-related value of plan assets over five years.

The company uses long-term historical actual return information, the mix of
investments that comprise plan assets and future estimates of long-term
investment returns by reference to external sources to develop its expected
return on plan assets.

The discount rate assumptions used for pension and non-pension postretirement
benefit plan accounting reflect the rates available on high-quality fixed-income
debt instruments at December 31 each year. The rate of future compensation
increases is determined by the company based upon its long-term plans for such
increases.

Changes in actual asset return experience and discount rate assumptions can
impact the company's stockholders' equity. Actual asset return experience
results in an increase or decrease in the asset base and this effect, in
conjunction with a decrease in the pension discount rate, may result in a plan's
assets being less than a plan's accumulated benefit obligation ("ABO"). The ABO
is the present value of benefits earned to date and is based on past
compensation levels. The company is required to show in its Consolidated
Statements of Financial Position a net liability that is at least equal to the
ABO less the market value of plan assets. This liability is referred to as an
additional minimum liability ("AML"). An AML, which is recorded and updated on
December 31 each year, is reflected as a long-term pension liability with the
offset in other

18

comprehensive earnings (loss) in the equity section of the Consolidated
Statements of Financial Position (on a net of tax basis) and/or as an intangible
asset to the degree a company has unrecognized prior service costs.

Income Taxes

The company estimates its tax liability based on current tax laws in the
statutory jurisdictions in which it operates. These estimates include judgments
about deferred tax assets and liabilities resulting from temporary differences
between assets and liabilities recognized for financial reporting purposes and
such amounts recognized for tax purposes, as well as about the realization of
deferred tax assets. If the provisions for current or deferred taxes are not
adequate, if the company is unable to realize certain deferred tax assets or if
the tax laws change unfavorably, the company could potentially experience
significant losses in excess of the reserves established. Likewise, if the
provisions for current and deferred taxes are in excess of those eventually
needed, if the company is able to realize additional deferred tax assets or if
tax laws change favorably, the company could potentially experience significant
gains.

RESTRUCTURING AND OTHER CHARGES

Although the company had substantially completed all restructuring activities at
December 31, 2002 and the employees had exited the business, approximately $4.7
million of severance payments were made during 2003. Refer to Note 15 of the
Notes to Consolidated Financial Statements for additional information regarding
the company's restructuring activities.

BASIS OF PRESENTATION

In 2001, the Emerging Issues Task Force ("EITF") reached a consensus that
consideration from a vendor to a purchaser of the vendor's products should be
characterized as a reduction in revenue as stated in EITF 00-25, Accounting for
Consideration from a Vendor to a Retailer in Connection with the Purchase or
Promotion of the Vendor's Products, and clarified in EITF 01-9. This EITF
consensus was effective for annual or interim financial statements beginning
after December 5, 2001, with reclassification required for comparative prior
periods. The company adopted this EITF as required in 2002 and the adoption of
this statement had no impact on the company's net earnings, financial position
or cash flows, but did result in a reclassification of certain prior year
reported amounts to conform to the current year's presentation. Both revenue and
selling, general and administrative expense for the twelve months ended December
31, 2001 were reduced by approximately $38.5 million as a result of this
reclassification.

RESULTS OF OPERATIONS

2003 COMPARED TO 2002

Consolidated revenue in 2003 was $4,755 million, an increase of 9% over 2002.
Revenue in the business market segment was $2,627 million in 2003 and increased
$242 million, or 10% compared to 2002. This growth was principally due to
increases in unit volumes. Revenue in the consumer market segment was $2,128
million in 2003 and increased $159 million, or 8% versus 2002. This growth was
principally due to increases in unit volumes. Total U.S. revenue increased $114
million or 6% and international revenue, including exports from the U.S.,
increased $284 million or 12%.

Consolidated gross profit was $1,545 million for 2003, an increase of 13% from
2002. Gross profit as a percentage of revenue for 2003 increased to 32.5% from
31.5% in 2002, an increase of 1.0 percentage point. The increase was principally
due to improved supplies margins (1.8 percentage points) and an increased mix of
supplies (0.9 percentage point), partially offset by lower printer margins (2.0
percentage points).

19

Total operating expense was $951 million in 2003, an increase of 11% from 2002.
Operating expense in 2002 included a $6 million benefit in the fourth quarter of
2002 from the reversal of previously accrued restructuring charges. Operating
expense as a percentage of revenue was 20.0%, compared to 19.7% for the
corresponding period of 2002. The 0.3 percentage point increase was primarily
due to the restructuring reserve reversal in 2002.

Consolidated operating income was $594 million in 2003 compared to $511 million
in 2002, a 16% increase. The increase in the consolidated operating income was
due to a $174 million increase in gross profit, partially offset by a $91
million increase in operating expense. Operating income for the business market
segment increased $132 million in 2003, principally due to increased supplies
sales. Operating income for the consumer market segment decreased $28 million in
2003, primarily due to lower printer margins.

Non-operating expenses declined $15 million from 2002 to 2003, principally due
to additional interest income in 2003 as a result of the company's strong cash
generation and the $5 million write-down of a private equity investment during
2002.

Net earnings were $439 million in 2003 compared to $367 million in 2002. The
increase in net earnings was primarily due to improved operating income and
lower non-operating expenses. The effective income tax rate remained at 26.0% in
2003 and 2002.

Basic net earnings per share were $3.43 for 2003 compared to $2.85 in 2002.
Diluted net earnings per share were $3.34 for 2003 compared to $2.79 in 2002.
The increases in basic and diluted net earnings per share were primarily due to
the increase in net earnings.

The following table sets forth the percentage of total revenue represented by
certain items reflected in the company's Consolidated Statements of Earnings:

2002 COMPARED TO 2001

Consolidated revenue in 2002 was $4,356 million, an increase of 6% over 2001.
Revenue in the business market segment was $2,386 million in 2002 and increased
$18 million, or 1% compared to 2001. This growth was principally due to an
increase in supplies unit volumes. Revenue in the consumer market segment was
$1,969 million in 2002 and increased $271 million, or 16% versus 2001. This
growth was principally due to increases in unit volumes. Total U.S. revenue
increased $196 million or 11% and international revenue, including exports from
the U.S., increased $56 million or 3%.

Consolidated gross profit was $1,371 million for 2002, an increase of 11% from
2001. Gross profit as a percentage of revenue for 2002 increased to 31.5% from
30.2% in 2001, an increase of 1.3 percentage points. The increase was
principally due to an increase to supplies in the product mix (2.3 percentage
points), higher supplies margins (1.1 percentage points) and the impact of a
restructuring related inventory charge of $29 million in 2001 (0.7 percentage
point), partially offset by lower printer margins (2.8 percentage points).

20

Total operating expense was $860 million in 2002, a decrease of 4% from 2001.
Operating expense in 2002 included a $6 million benefit in the fourth quarter of
2002 from the reversal of previously accrued restructuring charges and operating
expense in 2001 included a restructuring charge of approximately $58 million.
Operating expense as a percentage of revenue decreased to 19.7% in 2002 compared
to 21.9% in 2001. The 2.2 percentage point decrease was primarily due to the
restructuring charge in 2001 and the reversal in 2002 as well as the company's
continuing focus on expense management and the benefits of the restructuring
activities.

Consolidated operating income was $511 million in 2002 compared to $341 million
in 2001, a 50% increase. Included in the 2002 operating income was the $6
million restructuring reversal benefit noted previously and the 2001 operating
income included $88 million of restructuring and related charges. The increase
in the consolidated operating income was due to the impact of the restructuring
charges, the increased gross profit margin and the decrease in operating expense
as a percentage of revenue. Operating income for the business market segment
increased $85 million in 2002, principally due to increased supplies sales.
Operating income for the consumer market segment increased $39 million in 2002,
principally due to increased supplies sales.

Non-operating expenses declined $8 million from 2001 to 2002, principally due to
reduced borrowings at lower interest rates partially offset by a $5 million
write-down of a private equity investment during 2002.

Net earnings were $367 million in 2002 compared to $274 million in 2001.
Included in the 2002 net earnings was a $4 million after-tax benefit of the
restructuring reversal and the 2001 net earnings included restructuring and
related charges of $65 million after-tax as well as a $40 million benefit from
the resolution of income tax matters. After adjusting for the above-noted items,
the increase in net earnings was primarily due to improved operating income.
After adjusting for the $40 million tax benefit in 2001, the income tax
provision was 26.0% of earnings before tax for 2002 as compared to 26.5% in
2001. The decrease in the effective tax rate was primarily due to lower income
tax rates on manufacturing activities in certain countries.

Basic net earnings per share were $2.85 for 2002 compared to $2.11 in 2001. The
2002 basic net earnings per share included a $0.03 benefit from the
restructuring reversal and the 2001 basic net earnings per share included a
$0.50 negative impact from restructuring and related charges and a $0.31
positive impact from the income tax benefit. Diluted net earnings per share were
$2.79 for 2002 compared to $2.05 in 2001. The 2002 diluted net earnings per
share included a $0.03 benefit from the restructuring reversal and the 2001
diluted net earnings per share included a $0.48 negative impact from
restructuring actions and a $0.30 income tax benefit. After adjusting for the
noted items, the increases in basic and diluted net earnings per share were
primarily due to the increase in net earnings.

RETIREMENT-RELATED BENEFITS

The following table provides the total pre-tax cost/(income) related to
Lexmark's retirement plans for the years 2003, 2002 and 2001. Cost/(income)
amounts are included as an addition to/reduction from, respectively, the
company's cost and expense amounts in the Consolidated Statements of Earnings.

21

The company uses long-term historical actual return experience, the expected
investment mix of the plans' assets, and future estimates of long-term
investment returns to develop its assumed rate of return on pension assets used
in the net periodic pension calculation. The assumption is reviewed and set
annually at the beginning of each year. The company reduced its expected
long-term asset return assumption on the U.S. plan from 10.0% to 8.5% at the
beginning of 2003. This change, and the recognition of losses related to
negative pension asset returns over the past few years, increased the cost of
defined benefit plans in 2003. At the beginning of 2004, the company further
reduced its expected long-term asset return assumption on its U.S. plan from
8.5% to 8.0%. This change is expected to increase 2004 pension expense by
approximately $3 million.

The company annually sets its discount rate assumption for retirement-related
benefits accounting to reflect the rates available on high-quality, fixed-income
debt instruments at the end of each year. Using this process, the company
reduced its discount rate assumption in the U.S. from 7.5% to 6.5% at the end of
2002 and from 6.5% to 6.3% at the end of 2003. These changes, combined with
other changes in actuarial assumptions such as the assumed rate of compensation
increase, did not have a significant impact on the company's results of
operations for 2003, nor are they expected to have a material effect in 2004.

Future effects of retirement-related benefits, including the changes noted
above, on the operating results of the company depend on economic conditions,
employee demographics, mortality rates and investment performance.

LIQUIDITY AND CAPITAL RESOURCES

Lexmark's primary source of liquidity has been cash generated by operations,
which totaled $748 million, $816 million and $196 million in 2003, 2002 and
2001, respectively. Cash from operations generally has been sufficient to allow
the company to fund its working capital needs and finance its capital
expenditures during these periods along with the repurchase of approximately $5
million and $331 million of its Class A common stock during 2003 and 2002,
respectively. The company did not repurchase shares of its Class A common stock
during 2001. Management believes that cash provided by operations will continue
to be sufficient to meet operating and capital needs. However, in the event that
cash from operations is not sufficient, the company has other potential sources
of cash through utilization of its revolving credit facility, accounts
receivable financing program or other financing sources.

Cash flows from operating activities in 2003 were $748 million, compared to $816
million in 2002. These amounts were reduced during 2003 and 2002 by $108 million
and $50 million, respectively, due to contributions to the U.S. pension plan.
See Note 13 of the Notes to Consolidated Financial Statements for more
information regarding the 2003 pension contribution. Also contributing to the
change in cash flow from operating activities were unfavorable cash flow changes
in accrued liabilities, trade receivables and inventories, offset somewhat by
favorable cash flow changes in accounts payable and other assets and liabilities
as well as increased earnings. In 2002, cash provided by operating activities
increased from 2001 due to favorable cash flow changes in working capital
accounts, particularly trade receivables, accrued liabilities and inventories.

Cash used for investing activities in 2003 was $544 million, compared to $114
million in 2002. The company began investing in marketable securities during the
third quarter of 2003, which resulted in a net use of cash of $452 million in
2003. The company spent $94 million on capital expenditures during 2003,
compared to $112 million during 2002.

Cash provided by financing activities during 2003 was $36 million, compared $302
million cash used for financing activities during 2002. This $338 million
increase in cash from financing activities was primarily due to the purchase of
$331 million of treasury stock in 2002, compared to $5 million in 2003.

22

The company experienced some significant changes in other balance sheet accounts
in 2003. The decrease in prepaid expenses and other current assets was primarily
due to a reduction in prepaid income taxes ($43 million) due to a
reclassification of prepaid income taxes to net against accrued liabilities for
income taxes as well as a reduction in derivative assets ($33 million). Other
assets increased $29 million during 2003, primarily due to a $108 million
funding of the U.S. pension plan, offset somewhat by a $69 million decrease in
deferred tax assets.

Effective May 29, 2002, the company entered into a new $500 million unsecured,
revolving credit facility with a group of banks, including a $200 million
364-day portion and a $300 million 3-year portion. Upon entering into the new
credit agreement, the company terminated the prior $300 million unsecured,
revolving credit facility that was due to expire on January 27, 2003. There were
no amounts outstanding under the prior facility upon its termination.

Under the credit facility, the company may borrow in dollars, euros and certain
other currencies. The interest rate ranges from 0.35% to 1.25% above the London
Interbank Offered Rate ("LIBOR") for borrowings denominated in U.S. dollars, the
Eurocurrency Interbank Offered Rate ("EURIBOR") for borrowings denominated in
euros, or other relevant international interest rate for borrowings denominated
in another currency. The interest rate spread is based upon the company's debt
ratings. In addition, the company is required to pay a facility fee on the $500
million line of credit of 0.075% to 0.25% based upon the company's debt ratings.
The interest and facility fees are payable quarterly.

The credit agreement contains customary default provisions, leverage and
interest coverage restrictions and certain restrictions on secured and
subsidiary debt, disposition of assets, liens and mergers and acquisitions. The
364-day portion of the $500 million credit facility had a maturity date of May
28, 2003. During May 2003, each lender approved the extension of the $200
million 364-day portion of the revolving credit facility with a new maturity
date of May 26, 2004. The 3-year portion of the credit facility has a maturity
date of May 29, 2005. Any amounts outstanding under the credit facility are due
according to the applicable maturity dates noted above. As of December 31, 2003
and 2002, there were no amounts outstanding under the credit facility.

The company has outstanding $150 million principal amount of 6.75% senior notes
due May 15, 2008, which was initially priced at 98.998%, to yield 6.89% to
maturity. The senior notes contain typical restrictions on liens, sale leaseback
transactions, mergers and sales of assets. There are no sinking fund
requirements on the senior notes and they may be redeemed at any time at the
option of the company, at a redemption price as described in the related
indenture agreement, as supplemented and amended, in whole or in part. A balance
of $149 million (net of unamortized discount of $1 million) was outstanding at
December 31, 2003.

During October 2003, the company entered into interest rate swap contracts to
convert its $150 million principal amount of 6.75% senior notes from a fixed
interest rate to a variable interest rate. Interest rate swaps with a notional
amount of $150 million were executed whereby the company will receive interest
at a fixed rate of 6.75% and pay interest at a variable rate of approximately
2.76% above the six-month LIBOR. These interest rate swaps have a maturity date
of May 15, 2008, which is equivalent to the maturity date of the senior notes.

The company is in compliance with all covenants and other requirements set forth
in its debt agreements. The company does not have any rating downgrade triggers
that would accelerate the maturity dates of its revolving credit facility and
public debt. However, a downgrade in the company's credit rating could adversely
affect the company's ability to renew existing, or obtain access to new, credit
facilities in the future and could increase the cost of such facilities.

In February 2001, the company filed a shelf registration statement with the
Securities and Exchange Commission to register $200 million of debt securities.
Due to the company's strong

23

cash position, in early 2004 the company determined that it did not plan to
utilize the shelf registration, and on January 28, 2004, withdrew its
registration pursuant to the rules and regulations of the Securities and
Exchange Commission.

The following table summarizes the company's contractual obligations at December
31, 2003:

Purchase obligations reported in the table above include agreements to purchase
goods or services that are enforceable and legally binding on the company and
that specify all significant terms, including: fixed or minimum quantities to be
purchased; fixed, minimum or variable price provisions; and the approximate
timing of the transaction.

In October 2001, the company entered into an agreement to sell its U.S. trade
receivables on a limited recourse basis that allowed for a maximum amount of
financing availability of $225 million. In October 2003, the agreement was
amended and the maximum amount of U.S. trade receivables to be sold was
decreased to $200 million. As collections reduce previously sold receivables,
the company may replenish these with new receivables. The company bears a
limited risk of bad debt losses on U.S. trade receivables sold, since the
company over-collateralizes the receivables sold with additional eligible
receivables. The company addresses this risk of loss in its allowance for
doubtful accounts. Receivables sold may not include amounts over 90 days past
due or concentrations over certain limits with any one customer. This facility
contains customary affirmative and negative covenants as well as specific
provisions related to the quality of the accounts receivables sold. The facility
also contains customary cash control triggering events which, if triggered,
could adversely affect the company's liquidity and/or its ability to sell trade
receivables. A downgrade in the company's credit rating could reduce the
company's ability to sell trade receivables. The facility expires in October
2004, and required annual renewal of commitments in October 2002 and 2003. At
December 31, 2003 and 2002, the facility had no U.S. trade receivables sold and
outstanding.

At December 31, 2003 and 2002, the company did not have any relationship with
unconsolidated entities or financial partnerships, which other companies have
established for the purpose of facilitating off-balance sheet arrangements or
other contractually narrow or limited purposes. Therefore, the company is not
materially exposed to any financing, liquidity, market or credit risk that could
arise if the company had engaged in such relationships.

In July 2002, the company received authorization from the board of directors to
repurchase an additional $200 million of its Class A common stock for a total
repurchase authority of $1.4 billion. At December 31, 2003, there was
approximately $183 million of share repurchase authority remaining. This
repurchase authority allows the company, at management's discretion, to
selectively repurchase its stock from time to time in the open market or in
privately negotiated transactions depending upon market price and other factors.
During 2003, the company repurchased approximately 0.1 million shares in the
open market at prices ranging from $71.51 per share to $74.30 per share for a
cost of approximately $5 million. As of December 31, 2003, the company had
repurchased approximately 34.8 million shares at prices ranging from $10.63 per
share to $105.38 per share for an aggregate cost of approximately $1.2 billion.

24

CAPITAL EXPENDITURES

Capital expenditures totaled $94 million, $112 million and $214 million in 2003,
2002 and 2001, respectively. The capital expenditures were primarily
attributable to infrastructure support and new product development during 2003,
2002 and 2001. During 2004, the company expects capital expenditures to be
approximately $150 million, primarily attributable to new product development
and infrastructure support. The capital expenditures are expected to be funded
through cash from operations.

EFFECT OF CURRENCY EXCHANGE RATES AND EXCHANGE RATE RISK MANAGEMENT

Revenue derived from international sales, including exports from the United
States, make up about half of the company's consolidated revenue, with Europe
accounting for approximately two-thirds of international sales. Substantially
all foreign subsidiaries maintain their accounting records in their local
currencies. Consequently, period-to-period comparability of results of
operations is affected by fluctuations in currency exchange rates. Certain of
the company's Latin American entities use the U.S. dollar as their functional
currency. Lexmark's operations in Argentina were adversely impacted by currency
devaluation in late 2001 and the first six months of 2002. This resulted in
translation losses of approximately $5 million in 2002 and approximately $2
million in 2001. Since June 2002, the company did not experience significant
translation losses related to the Argentina operations.

Currency translation has significantly affected international revenue and cost
of revenue, but it did not have a material impact on operating income during
2002 and 2001. The 2003 operating income was materially positively impacted by
exchange rate fluctuations. The company acts to neutralize the effects of
exchange rate fluctuations through the use of operational hedges, such as
pricing actions and product sourcing decisions.

The company's exposure to exchange rate fluctuations generally cannot be
minimized solely through the use of operational hedges. Therefore, the company
utilizes financial instruments such as forward exchange contracts and currency
options to reduce the impact of exchange rate fluctuations on actual and
anticipated cash flow exposures and certain assets and liabilities which arise
from transactions denominated in currencies other than the functional currency.
The company does not purchase currency related financial instruments for
purposes other than exchange rate risk management.

TAX MATTERS

The company's effective income tax rate was approximately 26.0%, 26.0% and 13.9%
for 2003, 2002 and 2001, respectively. The 2001 effective income tax rate was
significantly impacted by the company's resolution with the Internal Revenue
Service ("IRS") on certain adjustments related to the allocation of intercompany
profits. As a result of this resolution, the company reversed previously accrued
taxes, reducing the tax provision in the fourth quarter of 2001 by $40 million.
Excluding the impact of this adjustment, the company's effective income tax rate
was 26.5% for 2001. Due to the anticipated expirations of favorable tax laws and
geographical shifts in earnings, the company expects the 2004 effective income
tax rate to be approximately 27.5%.

The IRS has completed its examination of the company's income tax returns for
all years through 1996. As of December 31, 2003, the IRS was in the process of
examining the company's income tax returns for the years 1997 through 2001.
Additionally, the company and its subsidiaries are subject to tax examinations
in various states and foreign jurisdictions. The company believes that adequate
amounts of taxes and related interest have been provided for any adjustments
that may result from these examinations.

As of December 31, 2003, the company had non-U.S. tax loss carryforwards of $3
million, which have an indefinite carryforward period.

25

RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board ("FASB") issued FIN
46, Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51. FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. In December 2003,
the FASB issued FIN 46-R, Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51 (revised December 2003), which replaces FIN 46. FIN
46-R incorporates certain modifications to FIN 46 adopted by the FASB subsequent
to the issuance of FIN 46, including modifications to the scope of FIN 46.
Additionally, FIN 46-R also incorporates much of the guidance previously issued
in the form of FASB Staff Positions. For all special purpose entities ("SPEs")
created prior to February 1, 2003, public entities must apply either the
provisions of FIN 46 or early adopt the provisions of FIN 46-R at the end of the
first interim or annual reporting period ending after December 15, 2003. The
company has evaluated the provisions of this interpretation and determined that
the interpretation has no impact on its financial position, results of
operations and cash flows.

In April 2003, the FASB issued SFAS 149, Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities. SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities
under SFAS 133. SFAS 149 is generally effective for contracts entered into or
modified after June 30, 2003. The company has evaluated the provisions of this
statement and determined that this statement has no impact on the company's
financial position, results of operations and cash flows.

In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers'
Disclosures about Pension and Other Postretirement Benefits. This Statement
revises employers' disclosures about pension plans and other postretirement
benefit plans. It does not change the measurement or recognition of those plans
required by SFAS 87, SFAS No. 88, Employers' Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination Benefits, and
SFAS 106. This Statement retains the disclosure requirements contained in SFAS
132, which it replaces. It requires additional disclosures to those in the
original SFAS 132 about the assets, obligations, cash flows and net periodic
benefit cost of defined benefit pension plans and other defined benefit
postretirement plans. The new rules also require additional disclosures in
interim financial statements about the amount of net periodic benefit cost
recognized and the amount of contributions paid or to be paid to a plan if
significantly different from amounts previously reported. The disclosures are
required to be provided separately for pension plans and for other
postretirement benefit plans. The newly required annual disclosures are included
in Note 13 of the Notes to Consolidated Financial Statements. The interim
disclosures are required for quarters beginning after December 15, 2003.

In December 2003, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 104, Revenue Recognition, which superceded SAB 101, Revenue
Recognition in Financial Statements. SAB 104 updated certain interpretive
guidance included in SAB 101, including the SAB 101 guidance related to multiple
element revenue arrangements, to reflect the issuance of EITF 00-21, Accounting
for Revenue Arrangements with Multiple Deliverables. The basic revenue
recognition principles of SAB 101 were largely unchanged by the issuance of SAB
104, and therefore, did not have a material impact on the company's financial
position, results of operations and cash flows.

In January 2004, the FASB issued FASB Staff Position ("FSP") No. FAS 106-1,
Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. FSP 106-1 permits employers who
sponsor postretirement benefit plans (plan sponsors) that provide prescription
drug benefits to retirees to make a one-time election to defer accounting for
any effects of the Medicare, Prescription Drug, Improvement and

26

Modernization Act of 2003 (the "Act"). Without FSP 106-1, plan sponsors would be
required under SFAS 106 to account for the effects of the Act in the fiscal
period that includes December 8, 2003, the date the President signed the Act
into law. For example, a calendar year plan sponsor would be required to account
for the Act for the first time in its 2003 year-end financial statements if it
uses a year-end measurement date, or in its financial statements for the first
quarter of calendar 2004 if it uses a September 30 measurement date. If deferral
is elected, the deferral must remain in effect until the earlier of (a) the
issuance of guidance by the FASB on how to account for the federal subsidy to be
provided to plan sponsors under the Act or (b) the remeasurement of plan assets
and obligations subsequent to January 31, 2004. The company has elected to defer
accounting for the effects of the Act.

INFLATION

The company is subject to the effects of changing prices and operates in an
industry where product prices are very competitive and subject to downward price
pressures. As a result, future increases in production costs or raw material
prices could have an adverse effect on the company's business. In an effort to
minimize the impact on earnings of any such increases, the company must
continually manage its product costs and manufacturing processes.

FACTORS THAT MAY AFFECT FUTURE RESULTS AND INFORMATION CONCERNING
FORWARD-LOOKING STATEMENTS

Statements contained in this report which are not statements of historical fact
are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements are made based upon management's current expectations
and beliefs concerning future developments and their potential effects upon the
company. There can be no assurance that future developments affecting the
company will be those anticipated by management, and there are a number of
factors that could adversely affect the company's future operating results or
cause the company's actual results to differ materially from the estimates or
expectations reflected in such forward-looking statements, including without
limitation, the factors set forth below:

- - The company and its major competitors, many of which have significantly
greater financial, marketing and/or technological resources than the company,
have regularly lowered prices on their products and are expected to continue to
do so. In particular, both the inkjet and laser printer markets have experienced
and are expected to continue to experience significant price pressure. Price
reductions on inkjet or laser products or the inability to reduce costs,
including warranty costs, contain expenses or increase or maintain sales as
currently expected, as well as price protection measures, could result in lower
profitability and jeopardize the company's ability to grow or maintain its
market share.

- - The company's future operating results may be adversely affected if it is
unable to continue to develop, manufacture and market products that are
reliable, competitive, and meet customers' needs. The markets for laser and
inkjet products and associated supplies are aggressively competitive, especially
with respect to pricing and the introduction of new technologies and products
offering improved features and functionality. The impact of competitive
activities on the sales volumes or revenue of the company, or the company's
inability to effectively deal with these competitive issues, could have a
material adverse effect on the company's ability to maintain or grow retail
shelf space or market share and on its financial results.

- - The introduction of products by the company or its competitors, or delays in
customer purchases of existing products in anticipation of new product
introductions by the company or its competitors and market acceptance of new
products and pricing programs, the reaction of competitors to any such new
products or programs, the life cycles of the company's products, as well as
delays in product development and manufacturing, and variations in the cost of
component parts, may impact sales, may cause a buildup in the company's
inventories, make

27

the transition from current products to new products difficult and could
adversely affect the company's future operating results. The competitive
pressure to develop technology and products and to increase marketing
expenditures also could cause significant changes in the level of the company's
operating expenses.

- - The company's performance depends in part upon its ability to successfully
forecast the timing and extent of customer demand and manage worldwide
distribution and inventory levels of the company and its resellers. Unexpected
fluctuations in reseller inventory levels could disru